This post is by PaulL, a regular commentor and occasional contributor.   It is the eighth post in a series on the financial incentives to work and the impacts of our tax and transfer system on household formation.  This post starts a new story arc – what could we do?  The index to all posts in the series can be found here.

To decide what we could do, and to compare between the various models we could use, we need a way to classify them.  I’m sure there are existing classification models, and I’ve done some (but not enough) research.  I’m going to classify in a way that matches how I think about incentives to work and income support.

Firstly, we can have financial solutions and non-financial solutions.  Financial solutions are things like benefits and abatement rates, non-financial solutions are things like work tests, case managers, or time limiting income support.

Starting with financial solutions, I think the salient attributes of the level of support are:

• The base amount of support – i.e. the dollar amount
• The abatement threshold and rate, if any
• The eligibility rules, if any

I think the combination of these three aspects covers pretty much all the supports I’ve seen.

Examples are:

• A fixed dollar amount with no eligibility rules and no abatement is a UBI
• A fixed dollar amount with no eligibility rules and 100% abatement is a guaranteed minimum income
• A dollar amount per child, payable only if you’re doing 20 hours of work and have children, and abating at 27c in the dollar above a certain threshold, is an in work tax credit
• A fixed dollar amount, with an income threshold and 27c in the dollar abatement rate, and with payment amount conditional on number of children, is a job seeker benefit

Using these attributes we can describe the outcome we’re giving to the household and the household type we’re giving it to, rather than the specific mechanism we use to deliver it.  We’re declaring the graph we want to have, and to some extent declaring the effective marginal tax rate (EMTR) we want to have.  From that we can back calculate how much it’d cost, and we can balance how much we want to spend against the incentives we want to create.

We also need to care about the interaction between these. When you have multiple programmes the aggregation of all of them is the effective rate that a household faces. In 2013 there was a significant restructure of the NZ income support system specifically to reduce the number of overlapping programmes, and to remove perverse incentives between them (e.g. disability benefits paying more than the dole, and therefore incentivising people to identify as disabled). In general that restructure looks to have improved a lot of things.

Separately we have implementation approaches – we can pay things as a benefit, as a refundable tax credit, arguably even a minimum wage fits into this framework.  Different implementation approaches impose different administrative costs – i.e. they matter to the taxpayers who fund it, but probably less to the person who’s receiving the income support.

We also have non-financial approaches.  The key ones that I can enumerate are:

• Case manager, training and other approaches intended to assist a person to move into work.  You could argue this is broadly the nagging approach
• Work tests and sanctions that are based on an obligation to have work – a reciprocity approach (we give you income support, you have obligations)
• Time limiting – either of this specific instance of being on income support, or total lifetime limits
• Reducing the non-financial attractiveness of income support – for example, requiring attendance for 20 hours a week to do some form of community work, which may make it just as attractive to do 20 hours of paid work instead

Some solutions may also lie in reducing the need for benefits.  NZ’s inequality hasn’t really changed in the last 20 years if you exclude housing costs (data here from pre-COVID).  Include housing costs, and you find that those who own houses got a lot wealthier (almost entirely house price increases) and those without houses lost disposable income (rental cost went up).

Accommodation supplement applies when accommodation costs are greater than 25% or 30% of the unabated benefit (depending on circumstances).  Accommodation supplement is a significant contributor to EMTRs.  If accommodation costs weren’t so high then the EMTR applying to those people would be reduced.  There may be other specific income supplements that could be addressed by fixing the underlying problem that gives rise to the need for the income supplement.

Each element has tradeoffs inherent in it.

The base rate of income support needs to be enough for someone to live on, to a level that the voters agree is sufficient.  A higher level increases cost, a lower level increases the number of people living in poverty.

The abatement rate is about targeting.  A high abatement rate means taxpayers only provide income support to those who are poor.  Once you can support yourself we rapidly reduce your income support.  This reduces cost to the taxpayer, but with an impact on incentives to work.  A higher threshold before abatement kicks in makes it easier for someone to do a few hours of work, but can create a point where it’s not economic to move from part time to full time.

In effect, if you say “that’s taxpayer dollars, we taxpayers only want to pay for people who need it, we don’t want middle class welfare”, then you’re also agreeing to very high abatement rates and lowered incentives to work.  Therefore you’re also agreeing to more people on a benefit.

Eligibility rules target the base amount to specific groups that need more money, those with children, for example.  This reduces the cost as compared to giving the money to everyone, but increases administrative costs and the perception of bureaucracy.  As soon as I declare your benefit depends on how many children you have, what happens if you have shared custody?  If other family members look after your children part time?  Who counts how many kids you have?

At the margin, you can also argue that “you get what you pay for.”  If people get more support with more children, then they may have more children, at least as compared to the counter factual where more children didn’t get more support.  Ideally targeting would focus on factors that people don’t easily change or are unlikely to change in response to incentives.

In a very real sense there is a tension between the EMTR and incentives to work, and the overall cost to the taxpayer.  Making it more attractive to enter work through a lower EMTR increases cost of the income support.

Having said that, the biggest element of cost is how many people require income support.  If our system traps people in poverty, then taxpayers end up providing income support to more people.  If our system encourages more people to move into work, then you can increase the generosity of the income support and abatement rates because fewer people are receiving income support.

In subsequent posts I’ll address some specific options such as a UBI, the pros and the cons and the costs.  Then I’ll put a suggestion on a policy package that could address some of our current problems.